The Day after Cyprus

During the Asian financial crisis, the chief economist of the IMF, Michael Mussa, once explained that there were three kinds of crises; liquidity, solvency and stupidity. The crisis in Europe continues to morph.

European officials have succeeded in stabilizing the situation with words of assurances. Despite the dramatic price action yesterday, there has been no follow through euro selling. European bourses have mostly stabilized. Spain's bourse is an exception, led by developments in the telecom space (Telefonica's filings) while financial shares are slightly firmer on the day. Spanish and Italian bonds are recovering from yesterday's slide.

Many participants are still trying to digest the meaning of Dijsselbloem's comments yesterday and also may be deterred from taking fresh positions due to month/quarter and fiscal year end. The confusion is not so much among investors as it is about the European officials themselves. Brussels immediately tried to play down the euro group head's comments. They have been resisting the German and IMF effort to shift more of the cost of the adjustment from tax payers to investors and, incidentally, uninsured depositors are unsecured creditors in cases of insolvency.

To square the circle drawn by Dijsselbloem's comments one needs to recognize that there some relatively unique aspects of the Cypriot situation, like divided island, the large role of Russia, including facilitating putting off the adjustment with a 2.5 bln euro loan a couple of years ago, and the reliance on deposits to fuel the financial expansion beyond any reasonable metric.

There is some sense that Cyprus is a turning point. We suggest that it is as much as Greece, Ireland, Portugal and Spain have been turning points. Institutional capacity is grown and innovation is forced. This is how the situation evolves. This is how EMU, only partially developed at birth, is developing. Germany and the IMF have long pushed for bailing in investors and they continue to press their case, when the opportunity presents itself. It is never an all out victory or defeat.

Cyprus and this latest European crisis continues to dominate other developments and the news stream is light in any case. Of note, new BOJ Governor Kuroda's comments before the Diet bolstered the JGB market and the 10-year yield fell to now decade lows near 0.53%. Kuroda was sympathetic to merge the Asset Purchase Program (APP) with the ongoing rinban operation (monthly BOJ purchases of JGBs) and to scrapping the self-imposed BOJ rule that limits JGB holdings to the amount of bank notes in circulation.

Essentially Kuroda has reinforced market expectations at the April 3-4 BOJ meeting (no longer much talk of an earlier, emergency meeting) that the central bank will increase the amount and duration of its JGB purchases and may increase its purchases of riskier assets, such as REITS, as well. Related, but separately, many expect the yen's weakness stabilized since earlier this month, will resume after the new fiscal year begins next week.

The US reports a slew of data today. Durable goods orders for February are expected to have rebounded from the 5.2% drop in January. This likely reflects the robust auto sector. CaseShiller home prices index is expected to extend recent increases. The 20-city price index was up 6.84% in December (year-over-year) and is expected to have risen toward 7.75% in January., which would be the fastest since June 2006. Separately new single family home sales will be reported. After a strong gain in January (15.6%), a small pullback is likely in February. Richmond Fed and Conference Board's Measure of consumer confidence will likely be overshadowed by the other data.